Corporate Risk Management: A Primer
4 important questions on Corporate Risk Management: A Primer
What are the advantages of hedging risk exposures?
- Decrease/reduce the high fixed costs associated with financial distress and bankruptcy
- Reduce earnings volatility to take effect of progressive tax rates (no higher tax)
- Increasing debt capacity (also increase interest tax deduction)
- Stabilize costs to stabilize prices
- REDUCE the cost of capital and enhance the ability to finance growth (Campello)
- Hedgers are able to invest more
- Economies of scale
- Access to better/more information
Practice:
- Markets are not perfectly efficient
- Find logic argument
What distinction between operations of the firm and its balance sheet?
Balance sheet: fair game, zero-sum game. Most important, what price is it willing to pay?
Summary:
- Should risk-manage their operation
- May also hedge their assets and liabilities
The decision to hedge is also, in effect, a risk management decision that may harm the firm if the risk exposure turns into a loss.
How can company determine whether to hedge specific risk factors, including the role of the board of directors and the process of mapping risks?
- Are they significantly important risk?
- What is the exposure?
- What are the costs/benefits?
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What are appropriate methods to hedge operational and financial risks, including pricing, foreign currency and interest rate risk?
- Internal, balance out
- Natural, borrowing money in foreign currency as well
- Derivatives (futures, options, forwards, swaps)
Most important is a static or dynamic strategy. This will go with different costs and complexity. Dynamic, can roll hedged over and over.
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